M/I Homes, Inc. (MHO) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon. My name is Sloan and I will be your conference operator today. At this time, I would like to welcome everyone to the M/I Homes First Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the conference over to Mr. Phil Creek. Please go ahead sir.

Thank you. And thank you joining us today. On the call is Bob Schottenstein, our CEO and President; Tom Mason, EVP; Derek Klutch, President of our Mortgage Company; Ann Marie Hunker, our VP and Corporate Controller; and Kevin Hake, Senior VP. First to address Regulation Fair Disclosure, we encourage you to ask any questions regarding issues that you consider material during this call because we are prohibited from discussing significant non-public items with you directly. And as to forward-looking statements, I want to remind everyone that the cautionary language about forward-looking statements contained in today’s press release also applies to any comments made during this call. Also be advised that the company undertakes no obligation to update any forward-looking statements made during this call. Also during this call, we disclose certain non-GAAP financial measures. A presentation of the most directly comparable financial measure calculated in accordance with GAAP and a reconciliation of the differences between the non-GAAP and the GAAP measure was included in our earnings release issued earlier today that is available on our website. Now I will turn the call over to Bob.

Thanks, Phil. Good afternoon and thank you for joining our call. As stated in our release issued this morning, we had a very strong first quarter and are off to a very good start in 2017. We feel really good about our results and are excited to share the highlights with you, led by a 56% increase in pretax income, a 170 basis point improvement in our operating margins, and many record setting achievements. We had record first quarter revenues of $407 million, 26% better than last year. Record closings or homes delivered of 1038 homes, 18% higher than last year’s first quarter. Record first quarter sales or new contracts of 1454 homes, 11% better than last year. In fact, our first quarter sales represents the highest number of new contracts for any quarter in our company’s history. Our first quarter backlog reached a ten-year high with a sales value of $834 million, 14% better than year ago. And unison backlog reached 2220 homes, approximately 13% higher than the year ago. Our average price of backlog was as expected, relatively flat coming in at $376,000 a home compared to $371,000 a year ago. We were also pleased to successfully open 24 new communities during the quarter, a record for quarterly openings, thus ending the quarter with 184 active communities, 2% higher than last year. Obviously we were very happy to see an 11% growth in sales with communities up only 2%. For 2017, we fully expect to increase our average community count by 5% to 10% over 2016. M/I Financial, our financial services business once again had a very strong quarter, increasing their pretax income by 45% over last year. Derek Klutch will discuss these results in more detail in a few minutes. And we continue to see improvement in profitability with year-over-year 80 basis point improvement in our adjusted gross margin as well as improved SG&A operating leverage. Now I’ll provide more detail of our specific regional housing markets and their performance. First, the southern region, which is comprised of our three Florida and four Texas markets. We had 419 deliveries during the quarter which represented 40% of total volume. New contracts in the southern region increased 20% year over year. We're achieving very solid results in all of our Florida markets. Orlando and Tampa sales were strong throughout the quarter and Sarasota in only a third quarter of operations for us, is also off to a solid start. We're excited about our new Sarasota division. In our Texas operations, new contract growth was strong in the first quarter with sales up in all four markets. Homes delivered were strong as well. The dollar value of sales backlog in the southern region at the end of the quarter was 19% higher than last year and our controlled lot position in our Southern region increased by 13% compared to a year ago. We had 87 communities in the southern region at the end of the quarter. This represents a 28% increase for March of last year and as to four Texas divisions specifically, we had 53 communities at the end of the quarter versus 40 a year ago. We continue to be excited about our growth opportunities throughout the southern region. Next is our Midwest region which consists of our operations in Columbus, Cincinnati, Indianapolis, Chicago and Minneapolis. The Midwest had 379 deliveries in the quarter, 18% increase from last year and 37% of company-wide total. New contracts for the Midwest region were up 12% for the quarter. We're very pleased with our results in all of our Midwest markets, particularly sale in our new Minneapolis division where we are acquiring five new communities from another builder. We expect meaningful growth in Minneapolis over the next several years. During the quarter, I also want to note that we opened our first time buyer smart series community in Columbus, Ohio. The smart series is our new line of more affordable product that we initially launched last year in Florida. So far this product has been very well received and we are excited about its rollout in future communities over the coming quarters and years. Our sales backlog in the Midwest was up 13% from the end of quarter one last year in dollar value and our controlled lot position in the Midwest increased 10% compared to a year ago. We ended the quarter with 63 active communities in the Midwest. This is a decrease of 13% from a year ago. Finally, our Mid-Atlantic region which consists of our Charlotte and Raleigh as well as D.C. markets. In the Mid-Atlantic, new contracts were down 6% for the quarter compared with a year ago. Our sales backlog value was up 9% at quarter end from year earlier. We ended the quarter with 34 active communities in the Mid-Atlantic region which is down 17% from a year ago. We delivered 240 homes, that's 240 homes in the Mid-Atlantic region during the first quarter. This is an 18% increase from a year ago and represents 23% of company-wide total. Our Raleigh operations had a very strong quarter with improvement in sale and deliveries, while Charlotte volume was a bit lower as new communities had not yet come online. But please note we have a very strong operation in Charlotte. Demand in the DC market remains uneven and we are managing our investment in this market very carefully. Our total lots controlled in the Mid-Atlantic region at the end of the quarter was essentially flat with last year, D.C. being down, both Charlotte and Raleigh increasing. Before I turn the call over to Phil, let me conclude by saying that we are well positioned to have a very good 2017. Our balance sheet is strong. Our net debt to capital ratios at 45%. We have a very good land position with over 24,000 lots under control and housing conditions remain favorable in most of our markets. Our strategy will continue to focus on improving our profitability both bottom line as well as our returns. Continuing to grow our market share in our existing markets, keenly focusing on quality and customer service, and investing in attractive land opportunities. Now, Phil will provide more specifics on our financial results.

Thanks, Bob. New contracts for the first quarter increased 11% to an all-time quarterly record of 1454. Our traffic for the quarter was up 2% and our community count was up 2%. Our new contracts were up 6% in January, up 10% in February, and up 14% in March. As to our buyer profile, about 37% of our first quarter sales were the first time buyers, compared to 45% in 2016’s fourth quarter, and 44% of our first quarter sales were inventory homes compared to 47% in 2016’s fourth quarter. Our active communities were 184 at the end of the quarter. The breakdown by region is 63 in the Midwest, 87 in the south, and 34in the Mid-Atlantic. During the quarter we opened a first quarter record 24 new communities while closing 18. For 2017 our current estimate is that our average community count for the year should be up about 5% to 10% over 2016 levels. We delivered 1038 homes in 2017’s first quarter, delivering 58% of our backlog compared to 57% a year ago. Revenue increased 25% in the first quarter over last year, reaching a first quarter record of $407 million. This was primarily result of an increase in the number of homes we delivered and average closing price as well as record revenue from our financial services operation. Our average closing price for the first quarter was $373,000, a 6% increase over last year’s $353,000. And our backlog sales price is $376,000, up 1% from a year ago. Land gross profit was $400,000 in 2017’s first quarter compared to $700,000 in last year's first quarter. We sell land as part of our land management strategy and as we see profit opportunities. Our first quarter gross margin was 21.3%, up 80 basis points year over year, and up 50 basis points over last year's fourth quarter, excluding stucco and impairment charges that we incurred in the respective 2016 periods. Our first quarter SG&A expenses were 13.5% of revenue, improving 20 basis points compared to 13.7% a year ago, reflecting greater leverage from higher closing revenue. Improving our operating efficiencies has been a major area of focus and we believe we will continue to see improved operating leverage as our newer divisions increase their volume and gain better scale. The dollar increase in SG&A was primarily related to the cost of opening new communities and higher payroll related costs from an increase in our employee count to support growth in our business and improvement in our results. Interest expense increased $73,0000 for the quarter compared to last year. Interest incurred for the quarter was $8.2 million, the same as last year's first quarter. We have $16 million in capitalized interest on our balance sheet. This is about 1% of our total assets. Our effective tax rate was 36% this year in the first quarter and we estimate our annual effective rate to be 36% as well. Our earnings per diluted share for the quarter was $0.55 per share. This per share amount reflects $1.2 million of dividends preferred to our preferred shareholders, and it’s calculated if our convertible notes converted, adding back the convertible interest and treating the related shares as if they are outstanding. Now Derek Klutch will address our mortgage company’s results.

Thanks, Phil. Our mortgage and title operations’ pretax income increased from $5.9 million in 2016’s first quarter to $8.6 million in the same period of 2017. Our first quarter results included an increase in the number of loans originated and the higher volume of loans sold as a result of the strong December closings. The quarter also benefited from the sale of a portion of our servicing portfolio, along with higher margins on the loans sold. The loan-to-value on our first mortgages for the quarter was 83% in 2017, down from 2016’s first quarter of 85%. 79% of the loans closed were conventional and 21% were FHA or VA. This compares to 71% and 29% respectively for 2016’s same period. Our average mortgage amount increased to $300,000 in 2017’s first quarter compared to $293,000 in 2016’s first quarter. Loans originated increased 20% from 604 to 725 and the volume of loans sold increased 26%. For the quarter, the average borrower credit score on mortgages originated by M/I Financial was 737, down slightly from 739 a quarter earlier. Our mortgage operation captured about 80% of our business in the first quarter, compared to 2016’s 82%. At March 31, 2017 we had $93 million outstanding under the MIF warehouse agreement, which is a $125 million commitment that expires in June of 2017. And we also had $14 million outstanding under a separate repo facility which expires in October. Both facilities are typical 364-day mortgage warehouse lines that we extend annually, and we expect the warehouse agreement extended prior to its expiration. Now I’ll turn the call back over to Phil.

Thanks Derek. We continue to manage our balance sheet carefully, focusing on investing in new communities while also managing our capital structure. Total home-building inventory at March 31, 2017 was $1.3 billion, an increase of $133 million, above last year levels primarily due to higher investment in our backlog, higher community count and more finished lots. So unsold land investment at March 31, 2017 is $588 million compared to $572 million a year ago. At March 31, we had $219 million of raw land and land under development and $369 million of finished unsold lots. We owned 4606 unsold finished lots with an average cost of $80,000 per lot, and this average lot cost is 21% of our $376,000 backlog average sale price. Our goal is to maintain about a one year supply of owned finished lots. The market breakdown of our $588 million of unsold land is $183 million in the Midwest, $257 million in the south, and $148 million in the Mid-Atlantic. Lots owned and controlled at March 31, 2017 totaled 24,400 lots, 43% of which were owned and 57% under contract. We owned 10,4000 lots, of which 34% are in the Midwest, 47% in the south, and 19% in the Mid-Atlantic. During 2017’s first quarter we spent $82 million on land purchases and $39 million on land development for a total of $121 million, about 20% of the purchase amount was for raw land. Our estimate today for 2017 land purchase and development spending is $500 million to $550 million. At the end of the quarter, we had 369 completed inventory homes, two per community and 993 total inventory homes. Of the total inventory, 279 nine are in the Midwest, 520 are in the southern region and 194 in the Mid Atlantic. At March 31, 2016 we had 326 completed inventory homes and 801 total inventory homes. Our financial condition continues to be strong with $672 million in equity and our home building debt to cap ratio of 45%. At March 31, 2017 we had $111 million outstanding under our $400 million unsecured revolving credit facility. We had $58 million of convertible debt due September of 2017 at a conversion share price of 23.80 per share. This completes our presentation. We’ll now open the call for any questions or comments.

[Operator Instructions] And your first call comes from Alan Ratner from Zelman & Associates.

Hey guys good afternoon. Congrats on a very strong quarter. My first question, it's pretty remarkable how consistent your order growth has been, and I think it's probably six or seven quarters in a row of double digit growth. And we are starting to hear from other builders just the idea that some pricing power might be returning to the market. And I'm curious as you look at your order pace and they're in a solid absorption level and it sounds like your community count growth is going to be accelerating. How are you thinking about the current price versus volume dynamic? And thinking about your margins, is there an effort there to maybe drive that higher at the expense of some of this volume growth or do you think that it's realistic to maintain this double-digit type growth at a stable to potentially improving margin?

That's a great question. This is Bob Schottenstein. I will take a crack at answering it. I think in terms of pricing pressure, and outlook for margins it's very -- we don't have any guidance in the market on it. And frankly, I think it's a little paralysis to try to give it because it's just very very difficult to predict things. Conditions are good now but it's very market specific and we do have pricing power in some communities but within the same -- the same city we might not have pricing power in others. I think if I had to guess and that's where a lot of this is, I see margins being about where they are. I mean, you know we're obviously seeing some pricing pressure on the raw material side, everybody's been talking about the last twelve hours on lumber increases. And you know, whether that's -- someone told me is it a paper cut or a splinter? I don't know what it is, but I do know it just costs more. And land prices continue to go up and admittedly there is very low inventory levels, mortgage rates continue to be extremely, extremely favourable. You know, a lot of the wind is at our back but yet I would think if you'd sort of shake all that up and pour it out, I see margins staying about where they are for the near term. And I think we can – as our volume continues to grow, we believe that we can not only improve our bottom line profit but a very central goal of our company is to improve our returns, which we've had success doing. In terms of our ability to continue to see at least consistent sales pace per community, if you grow communities by 10%, does that mean, you know, that that everything else goes up 10%? We would hope to maintain the sales pace that we're at. But we wouldn't be spending 500 -- this is a long answer to your question but we wouldn't be spending $500 million -- to 500 million -- to $550 rather million on land this year if we weren't a lot more optimistic about the continued traction that I think housing has. Not to say there won't be a hiccup every now and then but we feel good about housing over the next several years and we feel very good about the strength of our operating teams in the markets that we're in.

I appreciate that very comprehensive answer, Bob. It’s very helpful and you mentioned returns and your focus there, and I think it is worth noting the progress you've made there. Now look at your ROE up about 150 basis points year over year, and one of the things that really is striking to me is when I look at your land book, 57% of your lots right now you control through option contracts, which is one of the highest probably -- if not the highest rate you've seen in your company history. And it’s well above what other builders -- the other builders are probably skewed more towards two-third owned, one-third option. So just curious, if you could talk a little bit about the success you've had there in terms of finding option deals. I don't know if these are kind of hybrid land banking type arrangements or if they're true option deals. But that obviously is beneficial to your returns and I guess just as we think about that going forward and higher skew towards option deals, does that change the economics at all when we think about your margins or anything like that?

I think a lot of us want to want to jump in on that one but I'll start. First of all, job one, job two, and job three is to try to get the best possible communities that we can get in order for us to be selling our homes and communities where people want to live. That is really easy to say, it is not so easy to do. I've said this before, I'd rather pay more money for an A location and steal a B or B plus. And it matches sort of how we feel about it. Certain markets, there's a lot more opportunity to acquire lots on a takedown basis; others it is next to impossible. We're doing virtually – I don’t think we’re doing any land banking, if we are not aware of it. Phil is shaking his head, approving an agreement. So we have no land banking transaction. My sense is that the amount of option lots will drop but we feel great -- I appreciate your comment; we feel great that we can control 24,500 lots, only about 10,000 or 11,000 are actually on our books today. And while there may be a spot or two here in some of our markets where we are a little bit land poor, for the most part we have a very solid outlook on our land -- very solid view of our land position. Phil, did you want to add another to that?

No, as we came out of the downturn, we had taken the approach that we wouldn’t like to own a two to three year supply with a one year supply of finished lots, just because you don't want to be, you know, weather issues especially in the Midwest developer and they have to build in those type things. So we’ve pretty much been consistent about keeping a year of finished lots on the books. The interesting thing, if you look at the average finished lot costs, we talked about at the end of March the average finished lot cost was $80,000. Of course again that’s driven by location, product, a lot of different things. But if you compare that to the second quarter of last year, it was $80,000. The second quarter of 2015, it was $68,000. So just looking at the numbers we had a pretty big escalation in land costs but for different reasons that’s kind of slowed down. Of course we also talked about our purchases the first quarter only 20% which was one of the lowest we've had. But like Bob said, I wouldn't read a whole lot into that. I mean, premier locations is what we're always after but overall we feel really good about the land book we have right now.

Your next question comes from the line of Jay McCanless from Wedbush.

Hi good afternoon everyone and congrats on a good quarter. The first question I had on the gross margin, could you talk about the components of that, maybe housing versus financial services? And were there any one-time gains in there that we need to think about as we're modeling forth?

Jay, if you look overall – of course we gave a lot more detail in the release and also in the Q it will be but the house building margins were pretty flat first quarter of this year to last year. We did have very strong mortgage company results, when Derek talked about the gain on the sale of servicing that was not a significant number, that was a 200,000 to 300,000 pretax gain number. So it did come more from financial services, also there are some interest-corporate type numbers in there with a little bit annoying now and then. One of the things that also helps our margins the first quarter of this year versus last year in general was mild weather. We did not have the winter type expenses that we did a year ago. But you know, as Bob said, I mean we spend a whole lot of time, focusing on margins, we try to manage very carefully the way we open communities, only open a certain number of lots, try to make sure we do a good job from a product and pricing, we did open a whole lot of communities the first quarter, the most in our history. We also exceeded sales the first quarter in our new communities as opposed to what we talked. So there were some good things that contributed to our sales and margin numbers in the first quarter.

That’s helpful. In terms of the community growth through the rest of this year, could you talk about where -- are you going to be favoring one region over the other in terms of adding communities? And where – I guess, that one, and then I’ve got a follow up.

I will say one thing and then Phil can jump in. I think the business is about 40% in the South, and 40% in the Midwest, and almost 25% in the Mid-Atlantic, I know that adds up a little more than 100. Do you follow what I am saying? That’s about where it is now, expect it to sort of stay that way over the next year or so. And while the community openings may not necessarily reflect that, because there's a big difference between opening up a community with 200 lots and opening up a community with 1800. But Phil, you can give them the more –

We’re staying with the same estimate, Jay, that we had after year end results last year, we expect the average community count to be up 5% to 10%. So one number that looks a little bit strange the first quarter is that the Midwest community count is 63 compared to 72 a year ago. There are more communities opening in the Midwest in the next few quarters, we do expect to have more communities in the Midwest at year end than we started this year with. Of course, the south shows increase, Texas division is getting to scale, Sarasota starting out et cetera. The other area is the Mid-Atlantic which is only three divisions. Bob talks a little bit of the Charlotte communities not getting open, and again we had a couple of larger body of communities last year in Charlotte which is closed out. And in D.C. we do have a lower community count than a year ago. So I would expect, when we look at the end of the year, they'll be pretty good to ups in the Midwest, pretty good ups in the south, with the Mid-Atlantic off, mix that all together being up 5% to 10% for the year.

And then the last question I have is in terms of -- I know you guys disclosed the first time buyer versus move-up. But was there any change or radical change year over year in maybe attached product that you sold or something different in the conversation of what you're selling that would explain or add to the explanation of the improvement in the gross margin?

No, I mean we are – Bob talked a little bit about the smart series being a more affordable price point. But when you look throughout our price, throughout our product as far as entry level move up et cetera, the margins are not really significantly different.

[Operator Instructions] And you have a question from Alex Barron from Housing Research Center.

Thank you and congratulations guys on a good job this quarter. I wanted to ask about SG&A and just kind of how you feel about the potential for further leverage this year.

Well, Alex, as we said in our comments, based on our higher backlog and community count growth and expected growth, we expect to continue to get leverage there. We did get about 20 basis points the first quarter. So that was good, we do have more people than a year ago. We have 15 housing divisions; some of our access divisions are still getting the scale in a lot of new communities. So there are still increases going on but we do feel good about and plan to continue to get continued improvement in our SG&A leverage.

Any comments you can offer on how April has been shaping up for you?

We don't make any comments on that.

And any plans to enter any other markets or how do you think about M&A at this point?

There's no plans to enter any new markets at this time. Similar to what we said in previous calls, we continue to look. We think that if the right opportunity presented itself in certain markets that we have been looking at, that we wouldn't hesitate to open in another market or you know. Beyond that, nothing really to say in response to the question. End of Q&A

[Operator Instructions] And at this time we have no questions.

Well, thank you very much for joining us. Look forward to talking to you next quarter.